05/31/2014

The Absurd Insider Trading Case Against Phil Mickelson

The SEC and US Department of Justice have often overreached in their efforts to police insider trading, especially when they think they can make a big bang by taking down a high profile person (see, e.g., the asinine case against Mark Cuban), but the purported case against Phil Mickelson is one of the most absurd yet.

In the summer of 2011, a series of winning stock trades raised immediate red flags for financial regulators.

The traders — a cross-section of investors including the championship golfer Phil Mickelson and the high-rolling gambler and golf course owner William T. Walters — collectively reaped several million dollars betting on the consumer products companyClorox and one other stock, according to people briefed on the matter who spoke anonymously because they were not authorized to discuss the investigation.

The trades, options contracts to buy Clorox stock, came just days before the billionaire investor Carl C. Icahn announced an unsolicited takeover bid for the company that drove up the stock price. And trading records indicated that the bets came not just from Mr. Mickelson but also from at least one other investor connected to Mr. Walters and the golfing world, one of the people briefed on the matter said. ...

As federal authorities examine whether Mr. Icahn leaked details of his Clorox bid to Mr. Walters, the people said, they are exploring a theory that Mr. Walters might have passed the information to Mr. Mickelson.

This case stinks. It seems to me that there are two possible theories of liability of here, neither of which stands up to close scrutiny. First, Rule 14e-3 prohibits persons who occupy a certain status such as the offering person, the subject company, or an officer, director, partner or employee or any other person acting on behalf of the offering person or the issuer from tipping off other persons about an impending tender offer. Further, it prohibits thise tippees from trading on the basis of such information. But Rule 14e-3 only applies if the offering person (i.e., the takeover bidder, which would be Icahn in this case) has taken substantial steps towards commencing a tender offer. According to the NY Times, however, "in the case of Clorox, Mr. Icahn never submitted a tender offer." In addition, even if Icahn had taken the requisite substantial steps towards commending a tender offer, Mickelson would have to know or have reason to know that the information was non-public and came indirectly from Icahn.

Second, case law under Rule 10b-5 says that tipping material nonpublic information can sometimes be illegal. None of the players in this case are insiders of Clorox, so the classic disclose or abstain rule would not apply. Instead, the SEC would have to proceed under a misappropriation theory. In order for that to work, the SEC at a minimum would have to prove that (1) Icahn tipped the information to Walters in breach of a fiduciary duty owed to the person or entity who owned the information, (2) that Icahn got a personal benefit for doing so, (3) that Walters passed the information to Mickelson, (4) Mickelson knew or should have known that the information came was material, nonpublic, and had been disclosed to him in violation of a fiduciary duty by the source. It should also be the case that the SEC will have to prove that Mickelson knew or should have known that Icahn got a personal benefit from making the tip, although that issue is currently pending before the Second Circuit.

The SEC's case would break down at several points. First, does Icahn owe a duty to anyone (say the investors in his hedge funds) that was breached by his disclosure? After all, isn't Icahn really disclosing his own intentions? Indeed, Forbes reports that "Icahn himself owned more than 90% of his Icahn Enterprises and had already moved to return all the outside money in his hedge fund." Tipping or trading on the basis of your own intentions is not illegal under Rule 10b-5.

Second, what personal benefit did Icahn get from making the disclosure?

Third, what did Mickelson know and how did he learn it? Can they link his trade to Icahn and, if so, did Mickelson known that Icahn was breaching a fiduciary duty (assuming he was) by making the disclosure.

I am not unsympathetic to the argument that putative shareholder activists like Carl Icahn need watching. As the WSJ reports:

The investigation signals that the FBI and the SEC are concerned about a potential dark side of shareholder activism. Activist investors push for broad changes at companies or try to move stock prices with their arguments. Mr. Icahn, a 78-year-old billionaire, has come to epitomize such activism in U.S. boardrooms.

Investigators are focusing on potentially abusive practices among such activists, including whether they are leaking information about their stakes before making public disclosures—the subject of a Wall Street Journal page-one article in March.

But while abuses by activists should be policed, I just don't see how the SEC or DOJ can possibly make this case stick.

Comments

The Absurd Insider Trading Case Against Phil Mickelson

The SEC and US Department of Justice have often overreached in their efforts to police insider trading, especially when they think they can make a big bang by taking down a high profile person (see, e.g., the asinine case against Mark Cuban), but the purported case against Phil Mickelson is one of the most absurd yet.

In the summer of 2011, a series of winning stock trades raised immediate red flags for financial regulators.

The traders — a cross-section of investors including the championship golfer Phil Mickelson and the high-rolling gambler and golf course owner William T. Walters — collectively reaped several million dollars betting on the consumer products companyClorox and one other stock, according to people briefed on the matter who spoke anonymously because they were not authorized to discuss the investigation.

The trades, options contracts to buy Clorox stock, came just days before the billionaire investor Carl C. Icahn announced an unsolicited takeover bid for the company that drove up the stock price. And trading records indicated that the bets came not just from Mr. Mickelson but also from at least one other investor connected to Mr. Walters and the golfing world, one of the people briefed on the matter said. ...

As federal authorities examine whether Mr. Icahn leaked details of his Clorox bid to Mr. Walters, the people said, they are exploring a theory that Mr. Walters might have passed the information to Mr. Mickelson.

This case stinks. It seems to me that there are two possible theories of liability of here, neither of which stands up to close scrutiny. First, Rule 14e-3 prohibits persons who occupy a certain status such as the offering person, the subject company, or an officer, director, partner or employee or any other person acting on behalf of the offering person or the issuer from tipping off other persons about an impending tender offer. Further, it prohibits thise tippees from trading on the basis of such information. But Rule 14e-3 only applies if the offering person (i.e., the takeover bidder, which would be Icahn in this case) has taken substantial steps towards commencing a tender offer. According to the NY Times, however, "in the case of Clorox, Mr. Icahn never submitted a tender offer." In addition, even if Icahn had taken the requisite substantial steps towards commending a tender offer, Mickelson would have to know or have reason to know that the information was non-public and came indirectly from Icahn.

Second, case law under Rule 10b-5 says that tipping material nonpublic information can sometimes be illegal. None of the players in this case are insiders of Clorox, so the classic disclose or abstain rule would not apply. Instead, the SEC would have to proceed under a misappropriation theory. In order for that to work, the SEC at a minimum would have to prove that (1) Icahn tipped the information to Walters in breach of a fiduciary duty owed to the person or entity who owned the information, (2) that Icahn got a personal benefit for doing so, (3) that Walters passed the information to Mickelson, (4) Mickelson knew or should have known that the information came was material, nonpublic, and had been disclosed to him in violation of a fiduciary duty by the source. It should also be the case that the SEC will have to prove that Mickelson knew or should have known that Icahn got a personal benefit from making the tip, although that issue is currently pending before the Second Circuit.

The SEC's case would break down at several points. First, does Icahn owe a duty to anyone (say the investors in his hedge funds) that was breached by his disclosure? After all, isn't Icahn really disclosing his own intentions? Indeed, Forbes reports that "Icahn himself owned more than 90% of his Icahn Enterprises and had already moved to return all the outside money in his hedge fund." Tipping or trading on the basis of your own intentions is not illegal under Rule 10b-5.

Second, what personal benefit did Icahn get from making the disclosure?

Third, what did Mickelson know and how did he learn it? Can they link his trade to Icahn and, if so, did Mickelson known that Icahn was breaching a fiduciary duty (assuming he was) by making the disclosure.

I am not unsympathetic to the argument that putative shareholder activists like Carl Icahn need watching. As the WSJ reports:

The investigation signals that the FBI and the SEC are concerned about a potential dark side of shareholder activism. Activist investors push for broad changes at companies or try to move stock prices with their arguments. Mr. Icahn, a 78-year-old billionaire, has come to epitomize such activism in U.S. boardrooms.

Investigators are focusing on potentially abusive practices among such activists, including whether they are leaking information about their stakes before making public disclosures—the subject of a Wall Street Journal page-one article in March.

But while abuses by activists should be policed, I just don't see how the SEC or DOJ can possibly make this case stick.